Most people think of banks when they hear the term “financial industry”. While banks are the most important part of the financial industry, there are many other types of businesses that make up the sector.
Top financial stocks for beginners
These are some great options for beginners investors who can understand these mature financial businesses in the financial sector.
Berkshire Hathaway (NYSE.BRK.A.) (NYSE.BRK.B.) Although it is not often considered a stock in the financial sector, it is still an insurance company. Berkshire, which is led by Warren Buffett and also manages a huge reinsurance operation. The company’s stock portfolio is vastly accessible to investors, who also have large stakes in many major U.S. banks.
JPMorgan Chase is the U.S.’s largest bank and largest financial company. JPMorgan Chase is a difficult investment to recommend. JPMorgan Chase consistently has the highest profitability metrics in industry. It also has extensive operations in both investment and consumer banking.
Visa is the largest payment network in the world. It, along with Mastercard, has half the market share for the payment processing industry. Visa has plenty of growth potential, but don’t let this fool you. The company processes approximately $12 trillion annually in annualized payments volume each year. This is a small portion of the global cashless market that Visa’s management values as $185 trillion.
The Vanguard Financials ETF (NYSEMKT.VFH) is a good choice for financial sector exchange traded funds (ETFs). This fund provides portfolio exposure to all financial sectors and has a low expense ratio of 0.1% (an annual investment fee). The fund offers exposure to 377 different financial sector stocks. These stocks are weighted according their market capitalizations. The fund’s assets are more concentrated in larger financial companies. The top holdings are Bank of America, Citigroup(NYSE:C), BlackRock [NYSE:BLK], and Morgan Stanley.
Different types of financial stocks
The financial sector includes many different types of companies, not just banks. The function of companies in the financial sector is varied by their size and growth potential.
There are many ways to break down financial stocks, including:
Banks As mentioned previously, bank stocks account for the majority of the financial sector. There are three types of banks: Wells Fargo(NYSE:WFC) which offer deposit accounts and loans to individuals or businesses; investment banks such as Goldman Sachs [NYSE:GS] which offer services to high-net-worth investors and institutions; and universal banks such as JPMorgan Chase which serve both institutional and commercial clients.
Insurance The insurance subsector is the second largest part of the financial industry. It includes specialty insurers and life and health insurances as well as property and casualty insurances. Berkshire Hathaway is a major company in this subsector. This includes “insurtech” companies such as Lemonade, (NYSE:LMND).
Financial services There are companies that provide services in the areas of investing and public markets, but they are not considered to be banks or insurance companies. Two examples of financial service providers are the S&P Global ratings agency (NYSE:SPGI), and the futures market CME Group(NYSE:CME).
Mortgage REITs –Â These are companies that have mortgages or other financial instruments. They are also known as mortgage realestate investment trusts (REITs) in the financial sector.
Fintech is Companies that use technology to solve problems in the financial sector are called fintech. This category includes PayPal Holdings (NASDAQ :PYPL) and Block(NYSE :SQ). These companies were formerly known as Square.
Blockchain technology and cryptocurrency:Â Companies in the financial industry develop products and services using blockchain technology, and do business with cryptocurrencies like Bitcoin (CRYPTO.BTC).
SPACs A special-purpose acquisition company (or SPAC) is a company that has no business operations and exists to acquire another company. SPACs, also known as “blank-check” companies are part of the financial industry.
Analyzing financial sector investments
Investors can use both standard metrics such as the price to earnings (P/E), and the ones that are specific to the financial industry sector to evaluate investments in the financial industry. There are some important metrics that investors should consider for the insurance and banking subsectors of financial industry.
These metrics are particularly useful when analysing bank stocks.
Return-on-equity (ROE) & return on assets (ROA). These are two of the most commonly used metrics to show bank profitability. ROE and ROA represent a company’s annualized profit expressed in percentages of total assets and shareholders’ equity. Industry benchmarks are a 10% ROE or a 1% ROA.
Net Interest Margin (NIM: The majority of banks’ profits come from lending money to customers and charging interest. It is the difference between the average interest rate that a bank receives and what it pays. This is called its net interest margin.
Efficiency ratio: The efficiency ratio of a bank measures the amount that it spends to generate revenue. A 60% efficiency ratio would mean that a bank will spend $60 to generate $100 of revenue. Lower efficiency ratios are better.
Net Charge-off (NCO), ratio:Â This ratio is useful in comparing asset quality between different institutions, since it indicates the annualized percentage of bank loans that are written off as bad debt.
The price-to book (P/B), ratio: This ratio is useful for valuing bank stocks. It can be as useful as the PE ratio. The P/B ratio measures a company’s stock prices divided by its net assets value. The price-to-tangible-book-value (P/TBV) ratio may be even more useful than the P/B ratio because it excludes assets tough to value such as brand names and goodwill.
These are two important metrics to analyze stock insurance:
Combined ratio To calculate this ratio, add (or combine) the amount an insurance company pays in claims to the money it spends on business expenses. Add that amount to the premium income collected by the insurance company and you will see that it is lower than 100%. An insurer that has a lower combined ratio is likely to make more profit.
Investment margin Insurance companies make money from underwriting policies. They also invest the premiums they collect, instead of using it to pay insurance claims. It is vital to know how profitable an insurer invests, as this is often the main source of income for an insurance company.
